The purpose of this study is to empirically assess the determinants of the credit risk of Islamic Microfinance Institutions (MFIs). In particular, the study examines the explanatory factors for credit risk using a panel dataset of 20 Islamic MFIs located in the Middle East and South-East Asian countries during the period 2000-2015. The results show that credit risk depends on the following factors: the number of active borrowers, loan loss provision, the return on the gross portfolio, risk coverage, Return on Assets (ROA), inflation, the size and age of MFIs. However, the findings reveal that the debt ratio, capital ratio and GDP growth have no significant impact on the credit risk of Islamic MFIs. This paper is the first empirical work to investigate the critical factors of credit risk management in Islamic MFIs.

Description

Microfinance has become a buzzword in credit markets as a useful tool for poverty reduction and socioeconomic development. In the last two decades of the 20th century, due to the expansion of its services (loans, savings, capital guarantee, insurance and transfer of funds by migrants to their country of origin), microfinance was an example of both solidarity and interdependence.

In fact, the meaning of microfinance derives from its main characteristic and function provided. In this respect, it has been defined as the means by which the poor convert small amounts of money into lump sums (Mayoux, 2001). Moreover, microfinance is defined as the supply of loans and saving services to the poor (Schreiner, 2002). It is a way to financial inclusion as it provides financial flexibility to the poor people who are deprived of access to conventional financial services because of the limitations and preconditions that must be fulfilled in the formal sector (Muftiyas, 2008).

Several studies have suggested that microfinance has a significant impact on poverty reduction as well as on household wellbeing at different levels such as asset acquisition, food, health, security, household nutrition, women’s empowerment, children’s education, and social cohesion (Hashemi et al., 1996; Armendáriz and Morduch, 2000; Littlefield et al., 2003; Armendáriz and Morduch, 2005 and 2010; and Roodman and Morduch, 2009).